Money managers size up post-election economy

Mapping strategy if Obama or McCain wins White House is a challenge

By

SamMamudi

NEW YORK (MarketWatch) -- As Barack Obama and John McCain are poised to become their respective party's presidential nominee, money managers who ordinarily might already have an idea of where to invest after the November election are, like many U.S. voters, still undecided.

A clichéd view is that a Republican president helps sectors such as defense and healthcare and a Democratic president is good for, well, not much. The reality, of course, is more complicated that that - for instance, markets typically perform better during Democratic administrations than when a Republican is in the White House.

"It's amazing that with the election as close as it is, we have so few policies that we can bank on," said Mark Bavoso, head of U.S. asset allocation at Morgan Stanley Investment Management.

Part of this is because both candidates are veering away from policies that typically define their parties and moving more to the center. It's also because, said Bavoso, that in a turbulent year neither man wants to corner themselves with their promises.

"There's still no concrete [economic] plan from either candidate," said Mike Church, senior portfolio manager of the Church Cap Value fund
CVLAX
"And that's concerning."

"Uncertainty from the election has been one factor that's weighed on the markets," said Brian Levitt, corporate economist at OppenheimerFunds, Inc. He added that, historically, markets prefer one party in the White House and one in Congress. "Free markets like logjam in government," he said, because it usually means less regulation.

Church said that there's one fact that faces the country regardless of who wins: George Bush's legacy. "Bush came in with a budget surplus and he's leaving a budget deficit," he said.

And it's likely the deficit will only increase under a new administration -- the Tax Policy Center estimates that under Obama's plans tax revenues will reach 18.3% of GDP in the next decade, while McCain's plans will bring in 17.6% of GDP. But even at current levels, spending will account for 19.7% of GDP. The difference of 1%-2% doesn't sound like much, but GDP over the next 10 years will amount to $185 trillion.

Bavoso said he believes the results of Congressional elections will be just as important as who wins the presidency. Bob Doll, global chief investment officer of equities at BlackRock Inc., said that the biggest question is whether the Democrats reach the magic 60 number in the Senate. With 60 votes, the Democrats would be able to force legislation through the upper chamber regardless of who is president.

Expect a bigger tax bite under a new administration, though the pace and extent of the rises will depend on who wins. Despite McCain's tax-cutting promise, money managers predict that a Democratic majority in Congress all-but-guarantees the Bush administration's tax cuts will expire in 2010. In other words, expect higher capital gains, dividend and income taxes by 2011 at the latest.

Doll says that both candidates will raise taxes, and most likely before the expiration date. As Bavoso pointed out, McCain will still need a package that meets the approval of a heavily Democratic Congress.

The tax effect

"We handicap the outcome as investors to take the worst-case scenario," Bavoso said. The expectation of higher tax rates is already being discounted in the market and will continue to be into 2009, he noted.

Once taxes do rise, look for certain sectors to take a hit. "Higher taxes could create a challenge to disposable incomes," Bavoso said -- another blow to the already struggling consumer discretionary sector. "Fewer high-end retailers will do well," Doll added.

But while tax rises may hurt some equities, they can be good for the bond sector, especially tax-free municipal bonds.

Bob Williams, a principal research associate in the Tax Policy Center, said the tax increases should be taken in context. While the next administration might raise taxes overall compared to today's levels, the Bush cuts have brought the tax burden down to generational lows.

Sector benefits

Changes to the tax code may provide the new president with a way to promote pet projects. Sectors that could benefit, Bavoso predicted, are alternative energy and state and local healthcare. "Any areas that the president wants to feature will benefit from tax advantages to drive opportunities and investment," Bavoso said.

All the money managers agreed the alternative energy sector will benefit if Obama wins, though Church said the sector should improve regardless of November's outcome because of the likely introduction of a carbon trading scheme along with the continuing high price of oil. Church and Doll predicted that companies in the nuclear energy area will do well if McCain wins.

"McCain seems pretty convinced that nuclear power is the solution [to energy concerns]," Church said, though he added that this enthusiasm may be tempered by a Democratic Congress. Doll said that he expects traditional oil and gas companies also to do well under McCain.

As for the defense industry, Doll said that it would be wrong to think that a McCain victory would immediately lead to an uptick in that sector. "Given how long it takes to impact the defense budget, I think there'll be less difference in the early years," he said, adding that defense-related stocks could get a quick lift, however, from investors who expect better times ahead.

Doll added that infrastructure can be expected to better under Obama, while managed care companies in the healthcare sector should benefit from a McCain presidency. But, said Doll, fiscal conditions will hamper the more ambitious parts of either candidate's healthcare plans.

"It's going to be a sluggish at the start of anyone's administration," said Oppenheimer's Levitt. He suggested sectors with "long-term, secular growth" -- for instance, a booming healthcare industry as the country's population ages.

With tough times on the way, Bavoso at Morgan Stanley suggested a move into a specialized corner of the beleaguered financials sector -- investment management companies. "People will be seeking advice on how best to hold on to their money," he said, and investment managers should benefit.

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